EIU: 2013 Forecast – The global economy

The global economy will start slowly in 2013 but accelerate later in the year

The new year will begin with heavy clouds suspended over much of the global economy, but with the prospect of brightening later in 2013. A politically driven fiscal crisis in the US and austerity in the euro zone will, as the year starts, hold back growth in economies that collectively represent more than US$30trn of GDP. China is struggling to regain momentum, and most emerging markets are finishing their weakest year since the 2009 recession. The result is that economic growth in 2013 will be only slightly better than in 2012, and well below the pre-recession period and the stimulus-driven bounce-back year of 2010.

Nonetheless, the outlook will be brighter from mid-2013. The investment and consumption-dampening effects of the “fiscal cliff” negotiations in the US should be mostly over by mid-year, and the clear recoveries in the labour and housing markets will be better established. The euro zone, currently in a recession, will be growing again by the second-half of 2013, and China will be benefitting from noticeably higher investment and personal spending. The industrial cycle is also beginning to turn upwards for many bellwether emerging markets, in which production and exports have been stagnant or contracting for the last six months. All of this should, in the Economist Intelligence Unit’s view, set the stage for stronger growth in 2014.

Political tensions have weighed heavily on the global economy this year. Feuding among euro-zone governments over a solution to debt burdens in the weaker economies pushed the currency area dangerously close to catastrophe at mid-year. Those tensions have now eased, but they are not the only source of global political uncertainty. Factionalism in China’s government, normally kept under wraps, has spilled into the open this year, weakening investor confidence in an economy where growth was already slowing. The global political lens is now focused clearly on the US, where an unprecedented fiscal deadline looms on January 1st 2013. If the re-elected president, Barack Obama, and lawmakers in a divided Congress cannot agree on a new tax and spending plan, the country will face a fiscal squeeze of more than US$600bn in 2013, enough to push the US economy back into recession and suppress growth in much of the rest of the world.

The global economy has yet to recover fully from the 2008-09 recession, in part because of policy paralysis in the advanced economies. This was, in some ways, predictable. The slow recovery from the recession has sharpened the divide between right and left. Conservatives have pushed aggressively for fiscal consolidation and debt reduction as the only prudent response to the crisis. Those on the left have argued, with equal fervour, that austerity will simply depress growth further, delaying a recovery and punishing the less well-off. The rising income gap between those at the top and bottom of the socioeconomic scale has further inflamed tensions. Indeed, Mr Obama ran for re-election on the very specific pledge that he would raise taxes on the wealthy—a promise that he seems determined to keep, based on the hard line he is taking in negotiations with opposition Republicans in Congress. (source: The Economist Intelligence Unit)

Weakness in the euro zone is holding back growth globally

Europe’s economy remains, by far, the biggest anchor on global growth. The debt crisis has depressed lending, investment and private consumption throughout much of Europe, and has curbed imports of goods and services from other countries. Austerity programmes in most euro zone countries will prevent rapid improvement in 2013. Indeed, we downgraded our 2013 euro zone outlook last month, and now expect the single-currency bloc to contract in the new year. China’s economy, which has been responsible for an increasing share of global growth in the last decade, expanded by just 7.4% year on year in the July-September period, its weakest showing since the 2009 recession. The US has, however, been a relative bright spot: GDP growth in the third quarter expanded by a surprisingly strong 2.7%, revised upwards from 2%. We are, however, more cautious about US growth in the current quarter, largely owing to deteriorating sentiment surrounding negotiations over the fiscal cliff, the series of automatic spending cuts and tax rises—with a value of US$600bn in 2013—that will hit the economy at the start of the year if a deal is not reached. The Libor rigging scandal, which could leave a number of Western banks facing lawsuits and large claims for compensation, poses another threat to the world economy. It could exacerbate the ongoing process of balance-sheet deleveraging by Western—particularly European—banks, which is reducing the amount of financing available to businesses and households.

Nor are problems restricted to the developed world. The once-formidable BRICs (Brazil, Russia, India and China) are struggling as well. We have repeatedly cut our 2012 GDP forecasts for Brazil and India, and we are doing so again this month. Both economies, in the middle years of the last decade, appeared to have substantially increased their potential growth rates, but this now seems to have been a liquidity-driven mirage. Although India and Brazil are feeling the effects of their own policy shortcomings, they are also suffering from reduced demand for their exports, weaker capital inflows and general investor risk aversion—all consequences of the euro zone crisis. The slowdown is also spreading to other regionally important economies; we have, in recent months, lowered both our 2012 and 2013 GDP forecasts for South Africa, the engine of economic activity in Sub-Saharan Africa.

Indeed, the excesses of the last ten years—the personal debt accumulated in rich countries earlier in the decade and the public debt added during the recession—have saddled many countries with weak economic foundations and little or no resilience to stress of any kind. Europe, the weakest link in the global economic chain, is suffering from twin blows—an outright recession, stemming from weak consumer and business confidence and fiscal austerity—and a prolonged debt crisis that periodically sends financial markets into a panic, pushing up borrowing costs to unsustainable levels and threatening the break-up of the euro zone. (source: The Economist Intelligence Unit)

We see two potential paths for the euro and the US dollar

We see two possible paths for the euro:dollar exchange rate. If political conditions in the euro zone begin to stabilise, and in the light of the Fed’s new, open-ended bond-buying programme, it is possible that the dollar could settle at around US$1.30:€1, roughly its average during the last 12 months. In an extreme case, it could even fall to US$1.40:€1, where it spent much of 2011. Alternatively, a renewed bout of market concern over the euro zone—arising from political tensions or the failure of struggling economies to meet financial and economic targets—could again erode confidence in the euro and send the currency sharply lower. Given the propensity of market fears to overwhelm all else, and with the euro zone crisis certain to face more downdrafts, we see a limited upside potential for the euro in the coming months. In mid-December the US dollar was trading at US$1.293: €1.

The Fed’s decision to launch a third QE programme has been controversial with emerging-market policymakers, who are especially sensitive to appreciation of their currencies. Indeed, some officials, led by Guido Mantega, Brazil’s finance minister, are accusing the Fed of sparking a currency war by using monetary policy to weaken the US dollar. These complaints are exaggerated. The Fed does not use monetary policy to target the exchange rate; indeed, the Fed’s latest bond-buying programme is focused on mortgage-backed securities, partly in an effort to lift the property market and create more jobs in sectors related to housing. Moreover, not all currencies weakened against the US dollar in the aftermath of the Fed’s move: the Canadian and Australian currencies generally increased in value, perhaps because QE programmes are thought to boost the prices of commodities, which are the mainstays of the Canadian and Australian economies. Indeed, Mr Mantega’s own currency, Brazil’s Real, was virtually unchanged against the US dollar for months and has begun depreciating again. Nonetheless, although the Fed’s QE programmes, on balance, usually weaken the US dollar, they also have the potential to boost domestic demand in the US, which is positive for trade-dependent economies, given the outsized importance of the US in global trade. But the currencies of countries that have been fighting a host of domestic concerns and whose economies are sharply slowing—Brazil and India are examples—have been less sensitive to policy actions in the largest economies. (source: The Economist Intelligence Unit)